The Technology Stock Advisor Weekly Advice Column For May 28, 2008
Realistic Rates of Return
What Is Real?
One of my favorite stories was the Velveteen Rabbit, when the stuffed rabbit said he knew he was real because someone had hugged him so hard that the velvet had worn off of his nose.
Sometimes, when I see questions about real rates of return from investing, I think someone may need to have their nose rubbed hard, too.
A good example is the question submitted on the website Saving Advice by the investor who states that he has some “mad money” that he would like to invest and get double his money in one year.
Here is his question:
Investing for the little guy
“Lets say, for example, that I have $1000 in my mad money budget. Naturally, I'd like to double that over the next year or so. Without going into debt, how do I take such a small sum and invest it without buying stocks/bonds.”
Without Buying Stocks or Bonds?
The investment returns on stocks and bonds are one of the few places in the financial world where there is solid empirical evidence about performance over a long period of time.
Even if the investor who asked the question did not want to invest in stocks and bonds, the returns in that market provide a valuable benchmark to compare to other potential investments.
Since he wants to double his money, in one year, he needs at least a 100% gain on his $1000 investment.
How rare would that type of gain be in the stock market?
Stocks that doubled
In his investment column, Ben Steverman compiles the list of stocks that doubled over “a couple of years.”
He begins his story by stating, “In my new story and slideshow today, BusinessWeek asked fund managers and other stock market gurus to recommend stocks they think could double in the next couple years. As I say in the article, it’s a tough task: Less than 100 stocks — out of almost 6,700 that trade on major U.S. exchanges — succeeded in doubling in the past year, according to data provider Capital IQ.
Return Rates and Risk
A realistic rate of return on S&P 500 stocks over a long period of time would be about 10-12%. For risky private companies, that do not trade on the public markets, the economists at the University of New Hamshire estimate returns for private investments for 2007 ranged from 20% to 40%
Along the way to those rates of return, there is also a rate of loss. In any given 5 year period of time for the larger public stocks, there is a high likelihood that the initial investment could be down as much as 40%, or up as much as 40%.
For the private companies, there is about a 50% chance that the single private venture capital-backed company will go out of business in a three year period of time.
My Advice To The Investor
The term “mad money” is the right description of the idea that $1000 would double in one year.
One of the columnists wrote in to suggest that the investor open up an E Bay account and buy and sell goods online. Another suggested he go to Vegas and always bet on black on the roulette table.
I have a better idea: Buy a closed end government bond trust and put the dividends on reinvestment, and forget about the idea of doubling the amount in one year.
I would hazard a guess that my advice would result in about double whatever else the investor decided to do.
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